The art of asset allocation emerges as a guiding principle for building lasting wealth. It's about strategically distributing your investments across various asset classes, such as equities, debt, and gold, to achieve a balanced and resilient portfolio. Hence, using an investment strategy that actively adjusts a portfolio's asset mix based on market conditions is a necessity.
Strategic allocation
The allure of equities, with their potential for high returns, is undeniable. The Sensex, India's stock market benchmark, has showcased this potential, scaling remarkable heights over the years to currently near 80,000 levels. However, the journey hasn't been without its turbulence. The COVID-19 pandemic in 2020 sent shock waves through the markets, causing a steep decline. Similarly, the Russia-Ukraine war in recent times has triggered market volatility. These instances are stark reminders of the inherent risks associated with equities.
While equities fuel growth, they also carry the risk of significant downturns as seen in 2008, 2011, and 2015 when markets ended in the red. The ever-changing market dynamics highlight the importance of diversification. In 2015, when domestic equities fell 3%, Government Securities (G-Secs), considered a safe haven, offered stability with a 7% return. The next year too i.e. in 2016, equities inched up by 4% but G-Secs shot up by 15%. The contrasting performance of asset classes during different market cycles underscores the need for a diversified portfolio.
Balance risk & reward
Shift of allocation between asset classes can ensure a smoother investment journey. The significance of asset allocation cannot be overstated. Research suggests it's the driving force behind long-term portfolio performance, contributing a substantial 91.5%. This overshadows the impact of both 'security selection' and 'market timing', two factors that unfortunately get excessive attention from investors!
Plus, there is the emotional cycle of investors, swinging from euphoria at market peaks to panic at bottoms. Hence, people often succumb to emotional biases. Data reveals this pattern: in October 2021, when valuations were high, investors poured a massive Rs. 11,519 crores into the market. Conversely, in September 2013, amidst market lows, they withdrew Rs. 9,130 crores. The ideal approach would be to "buy low, sell high," but this is easier said than done. Recognising market peaks and troughs and timing investments is a formidable challenge.
Dynamic investing
This is where asset allocation strategies, adopted by certain mutual fund offerings, shine in a big way. Allocating the right asset at the right time is key. Dynamic strategies, which attack and defend as per changing market conditions, utilise sophisticated models to eliminate emotional biases. By increasing equity exposure during undervalued markets and decreasing it during overvalued ones, these strategies optimise returns while managing risk. This leads to protection during downturns, thus improving overall returns.
Consider the period from 2019 to 2024. During this time, the Sensex experienced both a flat phase (hovering around 40,000 in 2019-2020) and a rising phase (surpassing 60,000 in 2021-2023). A dynamic asset allocation model would have adapted to these conditions, increasing equity exposure during the flat phase to capitalise on the subsequent rise and reducing it as valuations soared to protect gains.
For retail investors, such asset allocation strategies can be a prudent choice. By relying on expert management and proven models, investors can navigate market complexities and work towards their financial goals with greater confidence.
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